ALLOWANCES – COSTS, BENEFITS & THE ENERGY/CLIMATE BILL

Carbon allowances -- the glue in House energy package
Peter Behr, May 26, 2009 (NY Times)

SUMMARY
The allocation of allowances will likely be the most important and controversial aspect of the energy/climate legislation that just emerged from the House Energy and Commerce Committee and is moving forward to face the rest of the House Committees on its way to a vote by the full House and an eventual meeting with comparable Senate legislation.

Representative Henry Waxman (D-Calif), Chair of the Energy and Commerce Committee, and Representative Ed Markey (D-Mass), the bill’s authors, compromised to allow the bulk of the allowances in their cap&trade system to be allocated free to major emitters during the introductory stages of the program.

Waxman and Markey were forced to compromise with supporters who believe the free allowances are necessary to smooth the transition to a market-based system that will for the first time put a price on greenhouse gas emissions (GhGs). By capping the amount U.S. emitters will be allowed to spew, the progression of global climate change can be marginally slowed.

Opponents believe the free allowances will make it possible for the big emitters to profit enormously from the system without significantly cutting emissions.

Utilities, oil companies, big industry and others that spew 25,000 tons or more per year and are collectively responsible for 85% of U.S. GhGs will be capped. The caps are aimed at bringing U.S. emissions to 17% below 1990 levels by 2020 and 83% below 1990 levels by 2050.

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The allowances permit companies to emit to the capped levels. If they emit beyond their supplies of allowances, they must purchase more allowances from companies that do not need what they are allocated or they must purchase offsets.

Offsets are investments in emissions cutting projects like rainforest protections or New Energy technologies.

Effective business planning that keeps emissions inside allowance limits with investment in New Energy and Energy and Efficiency is rewarded. Poor business planning will be progressively more costly as caps are firmly ratcheted down over time.

But not every geographic region and every business enters the new world of priced emissions equally.

Washington state, with abundant emissions-free hydroelectric power, emitted 0.15 ton of CO2 per megawatt of power in 2005. Indiana, which is coal-dependent, emitted nearly 1 ton of CO2 per megawatt. Where there is pre-existing dependence on heavily-emitting energy, the cost of transition will be higher. One computer estimate showed that caps will hit 3 times harder in coal states like West Virginia, Kentucky and North Dakota than in states that have New Energy resources like Washington, California and Oregon.

Different kinds of businesses will also bear different burdens. The chemicals, paper, cement and metals industries and oil refiners will be hit hard because they generate a lot of emissions. Companies that cannot pass part of the burden of increased costs on to consumers will also be hurt.

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Free allowances are intended to spread the burden of pricing emissions fairly in the early stages of the program by making it easier on regions and industries more dependent on emissions-intensive power sources.

Many, especially economists, believe a revenue neutral carbon tax would be a better choice to disincentivize emissions. Though they may be right, a tax is generally considered politically impossible because voters understand the word “tax” and invariably reject it and politicians who advocate it. Because big business has embraced cap&trade, voters may accept it and the politicians who advocate it, at least until they understand it better.

The Obama administration, Representatives Waxman and Markey and other proponents of cap&trade are working to present the system as a tool to fight global climate change.

Opponents are working to sell cap&trade as “cap and tax” and to make the voting public believe the new emissions trading market, where companies and investors will buy and sell allowances, is a convoluted and dangerous scheme that will benefit Wall Street, impose costs on the taxpayer and lead to a nightmarish crash even worse than the most recent financial meltdown.

Opponents also say free allowances make it possible for the worst emitters to game the market system for their own profit.

Proponents are working to assure voters regulations will be in place and costs will come back in the form of tax breaks and other benefits.

The legislation provides for a National Academy of Sciences review every 4 years. Critics say this is not frequent enough.

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COMMENTARY
The bill’s capped limits aim to keep GhG atmospheric concentrations to 450 ppm. Many environmentalists now believe atmospheric GhG concentrations must be brought down to 350 ppm to avoid the worst impacts of global climate change.

To protect New Energy resource-deficient states adequately to win political support for their bill, Waxman and Markey gave out abundant free allowances to coal states. It winds up being a defacto subsidy to the coal industry for the next 5-to-10 years. The bill also invests much taxpayer money in “clean” coal technology. This essentially subsidizes the very generation of GhGs the bill seeks to cap.

Waxman and Markey believe they are protected from harm and the aggravation of global climate change because the hard caps in their bill make it impossible for even such subsidized spew to go on.

The offsets in the Waxman-Markey legislation, although a smaller matter, are as controversial as the allowances. Offsets have been granted internationally under the terms of the Kyoto agreement for some years by the United Nations Framework Convention on Climate Change (UNFCCC). The program is called the Clean Development Mechanism (CDM). It allocates Certified Emissions Reductions (CERs) for investments in projects in the developing world that cut emissions or build New Energy. Critics say CDM projects lack additionality. The implication is that CDM offsets are little more than a source of financing for projects that would have been done whether they earned CERs or not.

But an Environmental Protection Agency (EPA) analysis showed the price of allowances will increase too rapidly if international offsets are not allowed. So Waxman and Markey included offsets in the legislation and assigned regulation of them to EPA. It is possible they could become as problematic as they were under the CDM but it is possible regulation and transparency could make offsets a serviceable adjunct to the cap&trade system.

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Projections for 2016 without an emissions reduction scheme: The U.S. economy produces ~7.3 billion tons of CO2. Regulated emitters produce ~6 billion tons of it.

Under Waxman-Markey: The cap permits only 5.26 billion tons. The 784 million ton gap must be closed with reduced economic activity, a move to New Energy, purchased offsets or the buying of allowances from companies that restrict their output of GhGs.

This allowance trading would put the price of a ton of emissions at ~$15-to-$20 in 2016, generating an emissions market value of $80-to-$108 billion. The Waxman-Markey bill formula gives that value away as allowances. Some goes to emitters such as the electricity industry (35%), local natural gas distributors (9%), "trade exposed" industries (14.2%) to prevent carbon leakage of business revenue, oil refiners (2%), automakers (3%), and energy companies investing in carbon capture and storage (2%).

The rest of the free allowances go to low- and moderate-income households (15%), university research grants (1%), tropical forest preservation (5%), and worker assistance and job training (0.5%).

The industry portion of the free allowances' value would either be used to generate emissions or sold for profits in the emissions markets. The balance would be sold in markets to provide revenues to the value holders.

The center of the debate is simply how much a cap&trade system will burden the average electricity ratepayer. The debate is heated. There are studies showing gains, low costs and high costs.

The EPA computer model predicts a small increase for U.S. households, about 0.2% lower in 2020 than in a business-as-usual scenario with no new climate legislation and costs imposed by the expense of adaptation to climate change. Household spending drops ~$140 a year. Gasoline prices increase 33 cents per gallon in 2030.

Critics say the EPA is way off because cap&trade’s governmental intrusion into the economy would have dramatic unintended consequences. The Republican staff of the House Oversight and Government Reform Committee found that cap&trade will cost the average U.S. household ~$1,600 a year. A conservative think tank expert called the Waxman-Markey cap&trade proposal "legalized plunder" by government.

Proponents say the high estimate of costs fails to understand the way allocations are traded to avoid business costs and the way system revenues are returned to ratepayers to offset higher power prices.

The Waxman-Markey legislation is nearly a thousand pages and includes a wide-ranging variety of other provisions. It creates, for instances, the first-ever national Renewable Electricity Standard (RES) requiring regulated utilities to obtain 155 of their power from New Energy sources by 2020.

It also provides funding for (1) Energy Efficiency, (2) a transition to electric transportation, (3) a New Energy high voltage tranmission superhighway, (4) new mass transportation, (5) green jobs and training programs and (6) adaptation programs for devastations associated with global climate change.

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QUOTES
- Robert Stavins, economist, Harvard University: "Some will have zero costs, some will have extremely high costs…It's very hard to estimate who will be the most burdened."
- Kevin Book, partner, ClearView: "The firm makes a choice…You can adapt. You can accept lower profits to retain customers, or, if you can jack up prices, you will. We don't know what the industrial players will do… Are we pushing this too fast? It seems like a reasonably prudent pace…There isn't a good business in the world that can't adapt if you give it 15 years. If it can't, it will be replaced by someone else who can."
- Myron Ebell, expert, Competitive Enterprise Institute: "It takes the most important economic decisions out of the hands of private individuals acting in the market and puts them in the hands of the government…"
- Mark Zandi, chief economist, Moody's Economy.com: "I think the economy can digest it if it is done in a clear, concerted and measured way…If you were king for a day, from a macroeconomic perspective, you wouldn't do it this way…Most economists would say the best approach would be a carbon tax, not cap and trade…[But cap and trade is] as good a second-best as policymakers can get."